Treatment of Corporate Reorganizations under the Corporate Minimum Tax

Publication Archived

Notice to the reader: Effective January 1, 2009, the Canada Revenue Agency (CRA) administers Ontario's corporate income tax, capital tax, corporate minimum tax, and the special additional tax on life insurers.

As a result, the Corporations Tax Act provisions described on this page and in other publications are only applicable to taxation years ending December 31, 2008 and prior.

For taxation years beginning January 1, 2009, the Taxation Act rules apply.

This publication was archived and kept for historical purposes. Use caution when you refer to it, since it reflects the law in force at the time it was released and may no longer apply.

The 2007 Ontario Budget proposed changes to the rules described in this Bulletin. See pages 187 and 188 of the 2007 Budget Papers for a description of the proposed changes. The 2007 Ontario Budget Papers are available on the Ministry of Finance website at ontario.ca/finance.

Introduction

This bulletin sets out the legislative concepts for the adjustments made to the corporate minimum tax (CMT) in respect of income tax deferred corporate reorganizations.

Subclauses 57.4(1)(a)(iv),(v), (vi), and (b)(ii),(iii), and (vi) of the Corporations Tax Act (the CTA) provide for amounts to be added to, and subtracted from, a corporation's CMT income in respect of income tax deferred corporate reorganizations.

Part 1. Income Tax-Deferred Elective Rollovers

General

Where a corporation or partnership (the transferor) disposes of an eligible property and elects under s. 85 or 97(2) of the Income Tax Act, (Canada) (the ITA), the transferor may also elect under s. 57.9 of the CTA to have any book gains that are deferred for CMT purposes as well. The election under CTAs. 57.9 must be filed jointly with the corporation or partnership (the transferee) that acquires the eligible property.

Corporations will have the choice of electing on all, some, or none of the property to which an ITA rollover applies.

Where assets are transferred at book value such that no gain is recognized for accounting purposes, there are no CMT adjustments to be made.

Treatment by Transferor

For CMT purposes, the amount of the transferor's CMT gain which can be deferred on the transfer of eligible property is equal to the lesser of: (i) the transferor's carrying amount (book value) of the share consideration received, and (ii) the book gain on the transferred property. This deferred gain is subtracted from the transferor's CMT income. The deferred CMT gain will be included in the transferor's CMT income when the transferor disposes of the shares taken back in the exchange, unless a subsequent CTAs. 57.9 election is made, or the shares are transferred as the result of a subsequent wind-up or amalgamation (see Part 2).

Treatment by Transferee: General

Where a gain is recognized by the transferor for accounting purposes, deferred for CMT purposes (by a CTAs. 57.9 election), and the carrying amount of the eligible property transferred is stepped-up in the transferee's books to the exchange amount (selling price), or some other value greater than the transferor's carrying amount, the transferee will be subject to adjustments which effectively give it the same accounting position with respect to the transferred property as that of the transferor.

Treatment by Transferee: Non-depreciable Capital Property

In the case of non-depreciable capital property, book gains deferred by the transferor are included in the transferee's CMT income in the year the transferee subsequently disposes of the property, unless a CTAs. 57.9 election is made, or the property is transferred as the result of a wind-up or amalgamation (see Part 2).

Treatment by Transferee: Depreciable Property

Deferred gains on depreciable/amortizable/depletable capital property will be added to the transferee's undepreciated deferred gain (UDG) balance for that property. A minimum yearly amount of the UDG balance will be amortized into the transferee's CMT income. The minimum yearly amount will be computed at the same rate as the transferee depreciates / amortizes / depletes the asset to which the gain relates. This will effectively add back any excess depreciation / amortization / depletion deducted from the transferee's CMT income resulting from the stepped-up carrying value. The transferee may add back any amount greater than the minimum up to its UDG balance. The UDG balance is reduced by the amount included in CMT income.

Where the transferee disposes of the depreciable property, the UDG balance is included in its CMT income unless a CTAs. 57.9 election is made on the transfer, or the property is transferred as the result of a wind-up or amalgamation as explained in Part 2.

Transferees will also be able to use an optional method. The optional method consists of using UDG pools. The deferred gains will be added to UDG pools according to the ITA class of asset to which the gain relates. The minimum yearly amount amortized into the transferee's CMT income is the UDG pool balance multiplied by the CCA rate prescribed in the ITA for that class of property (i.e., the UDG pool works like an inverse CCA pool. It provides an addback rather than a deduction). The transferee may add back any amount greater than the minimum up to its UDG pool balance. The UDG pool is reduced by the amount included in CMT income.

In addition to property that qualifies as eligible capital property for ITA purposes, the optional method will also be available for intangibles such as goodwill set-up for accounting purposes. The rate applicable to the UDG pool for such property will be 7%.

Subsequent Transfers

Where a corporation disposes of a property and elects under CTAs. 57.9 in respect of property that was previously subject to a CTAs. 57.9 election, the deferred gains and UDG balances will be eligible for transfer and further deferral, to the extent the deferred gains exceed the subsequent book losses on the property.

Income Tax Deferred Elective Rollovers: Example

Facts

Aco (transferor) transfers the following assets to Bco (transferee) in 1995:

FMV

Aco's carrying amount

LAND

$ 61,000

20,000

BUILDING

$134,000

100,000

195,000

120,000

In return, Aco receives a demand note in the amount of $130,000 and shares of Bco with a fair market value of $65,000.

Bco sells the land and building in 1997 for $70,000 and $140,000 respectively. No subsequent CTAs. 57.9 election is made and a wind-up or amalgamation did not occur at the time of the sale.

Accounting Treatment - Aco

Aco accounts for the transaction at fair market value. It recognizes a gain for book purposes in the amount of $75,000 computed as follows:

DrDemand note receivable

$130,000

DrInvestment in Bco

$ 65,000

Cr Land

$ 20,000

Cr Building

$100,000

Cr Gain on sale

$ 75,000

To book the sale of land and building to Bco

Income Tax Treatment - Aco

For income tax purposes the gain is deferred by transferring the property under section 85 ITA as follows:

Proceeds
(Agreed Transfer Amount)

Consideration Received

Demand Note

Shares

LAND

$ 20,000

20,000

41,000

BUILDING1

$110,000

110,000

24,000

130,000

65,000

Corporate Minimum Tax Treatment - Aco

Aco's gain on the transfer of land and building to Bco is included in Aco's financial statements as income and is therefore included in its CMT income under CTAs. 57.4(1)(a). Aco and Bco elect under CTAs. 57.9 to defer Aco's gain on the transfer for CMT purposes. As such, Aco can reduce its CMT income for the year ended December 31, 1995 by the amount prescribed for purposes of CTAs. 57.4(1)(b)(vi). The prescribed amount is determined as follows:

For The Land

the lesser of,

i) The Gain as Recognized in the Financial Statements

$41,000

ii) The Carrying Amount of the Shares Received

$41,000

Deduction from CMT Income for Land =

$41,000 (A)

For The Building

the lesser of:

i) The Gain as Recognized in the Financial Statements

$34,000

ii) The Carrying Amount of the Shares Received

$24,000

Deduction From CMT Income for Building =

$24,000 (B)

Total Deduction of the Transferor =

$65,000 (A)+(B)

1 UCC = $110,000

NOTE Aco was unable to defer the entire book gain of $75,000 because it received nonshare consideration (note receivable of $130,000) that exceeded the total carrying amount of the transferred assets of $120,000. See below:

Note Receivable

$130,000

Carrying Value -

Land

$ 20,000

Bldg

$100,000

$120,000

Excess of Non-Share Consideration Over Carrying Amount

$ 10,000

Book Gain

$ 75,000

Deferred Gain for CMT Purposes

$ 65,000

Gain Included in CMT Income

$ 10,000

Accounting Treatment - Bco

Bco also accounts for the transaction at fair market value. Bco will book the acquired assets at their fair market value as follows:

Dr Land

$ 61,000

Dr Building

$134,000

Cr Demand note

$130,000

Cr Share capital

$ 65,000

To book the purchase of land and building from Aco

Corporate Minimum Tax Treatment - Bco

Treatment of the Land

1995 - No effect. Land not disposed of in the year.

1996 - No effect. Land not disposed of in the year.

1997 - Land disposed of in the year. Bco must now add back the gain deferred by Aco on the sale of land in addition to any gain it recognizes in its financial statements.

Bco will show a gain in its financial statements of :

Selling Price

$70,000

Carrying Amount

$61,000

Gain per Financial Statements

$ 9,000

Bco must now also add back the gain deferred by Aco.

Deferred Gain on the Land

$41,000

Total Gain on Land Included in Bco's CMT Income

$50,000

NOTE If Aco had sold the property directly themselves at a selling price of $70,000, they would have recognized a gain in their financial statements of $50,000 ($70,000 - original carrying amount of $20,000).

Treatment of the Building

1995 & 1996 - For accounting purposes, Bco will depreciate the building over 40 years on a straight line basis (i.e., $134,000 ÷ 40 years = 3,350/yr).

The excess depreciation resulting from the step-up in the carrying value from $100,000 on Aco's books to $134,000 on Bco's books, to the extent the gain is not included in the Aco's CMT income, must be added back to Bco's CMT income annually.

Of the $34,000 step-up in carrying value, $24,000 was the deferred gain of the transferor (it is represented by the share carrying amount allocated to the land), and as such, $10,000 was included in Aco's CMT income. The $24,000 deferred gain amount will go into Bco's undepreciated deferred gain (UDG) balance for the building. From this balance, a minimum of $600 (i.e., $24,000 ÷ 40 years ) must be added to Bco's CMT income as excess depreciation annually.

Bco could include any amount in excess of the minimum from its UDG balance as an addition to its CMT income with a corresponding reduction to its UDG balance. In this example we have assumed Bco chose the minimum yearly amount. As such, their UDG balance is $22,800 at the end of 1996 (i.e., $24,000 - $600 - $600).

1997 - In the year of sale of the building, the UDG balance for the building must be added to Bco's CMT income in addition to any gain it recognizes in its financial statements.

Bco will show a gain in its financial statements of :

Selling Price

$140,000

Carrying Amount ($134,000 − $3,350 − $3,350)

$127,300

Gain per Financial Statements

$ 12,700

Bco must now also add back the remaining UDG balance attributable to the building.

UDG Balance of the Building

$ 22,800

Total Gain on the Building Included in Bco's CMT Income

35,500

Reconciliation

Gain deferred

$24,000

Increase in Value Over Exchange Amount ($140,000 - $134,000)

$ 6,000

Accounting Depreciation Claimed

$ 6,700

Less: UDG Amortized to CMT Income

($1,200)

35,500

NOTE Rather than tracking the UDG balance of individual assets, Bco could have used the optional method and added the deferred gain to a UDG pool balance. A building is a class 1 asset under the ITA capital cost allowance regulations with a CCA rate of 4%. Consequently, the $24,000 amount could have gone into the class 1 UDG pool balance. The minimum yearly addback to CMT income for a class 1 UDG pool is 4%.

1995 - class 1 pool balance $24,000 × 4% × 1/2 year2 = $480

1996 - class 1 pool balance ($24,000 − $480) × 4% = $941

1997 - The UDG pool balance is added to CMT income on the sale of the building.

Pool balance = $24,000 − $480 − $941 = $22,579

Total CMT gain in 1997 under the optional method:

UDG pool balance

$22,579

1997 Accounting Gain on Building

$12,700

Total CMT gain

$35,279

2 The half-year rule will apply to UDG pools in the year of acquisition.

Part 2. Automatic Rollovers (Amalgamations and Wind-ups)

General

Where property is transferred under the automatic rollover provisions of section 87 or 88 of the ITA, accounting gains recognized on the wind-up or amalgamation are exempt for CMT purposes to the extent they are exempt for CIT purposes, and to the extent they exceed any previous write-downs by one of the parties, with respect to its investment in another party involved in the transaction. The CMT income will be adjusted to remove these gains.

Where transferred property has been stepped up in value on an amalgamation or wind-up in excess of the carrying amounts of the parties involved in the transaction, CMT adjustments will be required. These adjustments effectively restate the asset values to the original carrying amounts of the parties involved in the transaction for purposes of determining CMT income.

The adjustments required for CMT purposes in these situations are made under CTAs. 57.4(1)(a)(v)(vi) and (b)(ii)(iii). The rules to determine these adjustments are essentially the same as those that apply where a CTAs. 57.9 election occurs (see Part 1).

If properties are transferred to a parent company on a wind-up (or amalgamation), no accounting gain or loss is recognized by the parent, and the assets are booked at the parent's consolidated carrying amount in its pre-wind-up (or pre-amalgamation) consolidated balance sheet, then no CMT adjustments will be necessary. If an amalgamation of other than a parent and subsidiary takes place, no accounting gains or losses are recognized by the parties involved in the transaction, and all the assets are transferred at the carrying amounts of the parties involved, then no CMT adjustments will be necessary.

Subsequent Amalgamations and Wind-Ups

Deferred gains and UDG balances resulting from a CTAs. 57.9 election, an amalgamation, or a wind-up flow through with the property on subsequent CTAs. 57.9 elections, amalgamations and wind-ups.

Automatic Rollovers: Example

Facts

Pco is a new company capitalized with $200 cash.

Pco purchases Sco for its FMV of $200 at January 1, 19x1.

Sco carries on its books a $50 depreciable asset and a $50 non-depreciable asset.

Sco was originally capitalized with $100 and has never had a profit or loss.

The purchase price is allocated as follows:

depreciable asset

= $ 50

non-depreciable

= $100

goodwill

= $ 50

$ 200

Sco makes a profit of $30 in 19x1, none of which is distributed (for simplicity, assume no depreciation or amortization was claimed).

Sco and Pco's financial positions as at December, 19x1 are as follows:

Sco
Balance Sheet
December 31, 19x1

Cash

30

Depreciable Asset

50

Capital Stock

100

Non-Depreciable Asset

50

Retained Earnings

30

130

130

Sco
Income Statement
December 31, 19x1

Profit for the Year

30

Pco
Balance Sheet
(Unconsolidated - Cost Method)
December 31, 19x1

Investment in Sco

200

Capital Stock

200

Pco
Income Statement
(Unconsolidated)
December 31, 19x1

Profit(loss) for the year

0

Pco
Consolidated Balance sheet
December 31, 19x1

Cash

30

Goodwill

50

Depreciable Asset

50

Capital Stock

200

Non-Depreciable Asset

100

Retained Earnings

30

230

230

Pco
Consolidated Income Statement
December 31, 19x1

Profit for the year

30

On January 1, 19x2 Sco is wound up into Pco under ITA 88(1). Sco's fair market value on January 1, 19x2 is $350 allocated as follows:

cash

= $ 30

depreciable asset

= $100

non-depreciable

= $110

goodwill

= $110

$ 350

All of Sco's assets are transferred to Pco at fair market value and accounted for at fair market value.

Pco disposes of the non-depreciable asset in 19x4 for $130.

No subsequent CTAs. 57.9 election is made, nor is the property subsequently transferred by a subsequent amalgamation or wind-up.

Pco's financial statements immediately after the windup are as follows:

Pco
Interim balance sheet
January 1, 19x2

Assets

Liabilities and shareholders equity

Cash

30

Goodwill

110

Depreciable asset

100

Capital stock

200

Non-depreciable

110

Retained Earnings

150

350

350

Pco
Interim Income statement

Gain on wind-up

1503

3CTAs. 57.1 precludes a corporation from using the equity or consolidation methods of accounting to compute their CMT income. Therefore, assuming the transaction is accounted for at fair market value and using the cost basis of accounting, the gain on wind-up is computed as follows: The proceeds received by Pco have a fair market value of $350, the carrying amount of Sco on Pco's books using the cost method is $200, therefore the gain is $350 - $200 = $150.

CMT Treatment of the Gain on Wind-up - Pco

Pco has recorded a $150 accounting gain on the wind-up of Sco.

For CIT purposes, Pco will have a gain of nil due to the deemed proceeds rules under ITAs. 88(1)(b). Therefore, for CMT purposes, the $150 accounting gain is subtracted from Pco's CMT income.

CMT Treatment of the Transferred Assets

Pco has: i) stepped up the value of goodwill to $110 from the $50 it showed on its consolidated balance sheet, ii) stepped up the value of its non-depreciable asset to $110 from the $100 it showed on its consolidated balance sheet, and iii) stepped up the value of its depreciable asset to $100 from the $50 it showed on its consolidated balance sheet.

As Pco has stepped up the value of the assets on wind-up to amounts in excess of its consolidated balance sheet costs immediately before the wind-up, adjustments are required to Pco's CMT income in respect of these assets.

CMT Adjustment for Goodwill

For accounting purposes, Pco will amortize the goodwill over 40 years on a straight line basis (i.e., $110 / 40 years = $2.75).

The excess amortization resulting from the step-up in the carrying value of the goodwill from $50 on Sco's books to $110 on Pco's books, to the extent the step-up is not included in Pco's CMT income, must be added back to Pco's CMT income annually. Of the $60 step-up in carrying value, none of the amount was included in Pco's CMT income; therefore, the $60 step-up will go into Pco's UDG balance for the goodwill. From this balance, a minimum of $60 / 40 years = $1.50 must be added to Pco's CMT income annually as excess amortization. (Note As discussed in Part 1, Pco may include any amount up to its UDG balance in its CMT income for the year. Also, Pco may choose to use the optional UDG pool balance method discussed in Part 1.)

CMT Adjustment for Depreciable Asset

For accounting purposes, Pco will depreciate the depreciable asset on a straight line basis over 5 years (i.e., $100/5 years = $20/year).

The excess amortization resulting from the step-up in the carrying value of the depreciable asset from $50 on Sco's books to $100 on Pco's books, to the extent the step-up is not included in Pco's CMT income, must be added back to Pco's CMT income annually. Of the $50 step-up in carrying value, none of the amount was included in Pco's CMT income; therefore, the $50 step-up will go into Pco's UDG balance for that depreciable asset. From this balance, a minimum of $50 / 10 years = $10.00 must be added to Pco's CMT income annually as excess amortization. (Note As discussed in Part 1, Pco may include any amount up to its UDG balance in its CMT income for the year. Also, Pco may choose to use the optional UDG pool method discussed in Part 1.)

Non-Depreciable Asset

19x2 - No effect. The non-depreciable asset was not disposed of in the year.

19x3 - No effect. The non-depreciable asset was not disposed of in the year

19x4 - The non-depreciable asset sold in the year. Pco must add back the step-up in carrying value of the property.

Pco will show the following gain in its financial statements :

Selling Price

$130

Carrying Amount

$110

Gain per Financial Statements

$ 20

For CMT purposes, Pco must add back the step-up in carrying value that occurred on the wind-up.

Step-up on the Non-Depreciable Property

$ 10

Total Gain on Land Included in Pco's CMT Income

$ 30

Part 3. Subsidiaries with CMT Loss Carryforwards

Under CTAs. 57.5(8) and (9), CMT loss carryforwards on amalgamations or wind-ups flow through to the new corporation or parent, as the case may be. However, by virtue of regulations under CTAs. 57.4(1)(b)(ii) and (iii), where a company winds up a subsidiary or amalgamates with a subsidiary that has CMT loss carryforwards, any accounting loss recognized by the company on, or anytime prior to (e.g., prior year write downs), the windup or amalgamation will be denied to the extent of the subsidiary's CMT loss carryforwards that are transferred to the company (or to the Newco if an amalgamation).

Loss Carryforward Transferred from Subsidiary: Example

Facts

Sco is a subsidiary of Pco.

Sco is carried on Pco's books at $200 and has a fair market value of $100.

Sco has CMT loss carryforwards of $50.

Pco winds-up Sco and books the transaction at fair market value. Using the cost method of accounting, the financial statements will show a loss of $100 for accounting purposes.

CMT Treatment-Pco

The accounting loss will be denied to the extent of the subsidiary's loss carryforwards. The accounting loss in this case is reduced by $50.

Loss denied under CTAs. 57.4(1)(a)(v) and (vi) is the lesser of:

I) Accounting Loss

$100

ii) CMT Loss Carryforwards [CTA 57.5(8)&(9)]

$ 50

= $50

Part 4. Application Date and Transition Rules

Application Date

The regulations relating to CTAs. 57.9 elections will be applicable to all taxation years to which the CMT applies, including those years used to compute a corporation's pre-1994 loss. The regulations relating to amalgamations and wind-ups will apply to transactions occurring after 1993.

Transition Rules for Depreciable Property

For taxation years ending before a future date to be specified by the Minister (the "Specified Date"), corporations can choose not to include the minimum yearly amount of UDG (or UDG pool amortization) in their CMT income. However, where a depreciable property is disposed of in a taxation year ending prior to the Specified Date, the rules regarding the add-back of the UDG balance or UDG pool balance to CMT income will apply.

Late or Amended Elections

Late or amended CTAs. 57.9 elections will be accepted until 180 days after the Specified Date.

To obtain the most current version of this document, visit ontario.ca/finance and enter 494 in the find page field at the bottom of the webpage or contact the ministry at 1 866 668-8297 (1 800 263-7776 for teletypewriter).